(& that action contributes to decreasing overall money supply which propagates a deflationary spiral.)
And that is where I believe you are wrong. In bitcoin land, paying back a loan does not reduce the supply of money, so there is no deflationary spiral. In bitcoin land, paying back a loan simply means that those bitcoins are once again available to be loaned out.
Just plain old deflation, which is good for savers and bad for debtors (the exact opposite of inflation, which is good for debtors and bad for savers).
once you pay back the loan, nobody will take out another loan, based on the preceding argument. the drying up of all lending activity starts the spiral.
i am assuming that BTC is the only currency that exists. in the real world, people would just continue to loan in USD, which we trust the banks to keep at stable low inflation rates.
the point of the conversation is to highlight why BTC needs to address the limited supply issue before it will achieve stability and potential to truly become a widespread currency like the dollar.